Question

a. What seems to be the main motives estate builders have for saving?

b. Why do their motives for saving matter when we try to evaluate the social efficiency of the estate tax?  

Answer 1

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Perhaps a left-field advantage, but investing in property improves your financial know-how. The simple act of saving for a deposit teaches financial discipline; working the numbers in terms of affordability prior to purchase is essential, and once an investment has been acquired, the juggling act of dealing with holding costs, rental income and tax benefits not only requires some monetary dexterity, but also makes you more capable of managing your money – and making the most of every cent.

1. Tax breaks – negative gearing

Speaking of tax benefits, we’d be remiss not to highlight one of the most important benefits for investors: the fact that the tax office allows you to write off investment expenses against tax, thus lowering your income and your tax bill and offsetting any shortfall between rental income and holding costs either partially or in full. This makes investing in property more affordable for the everyday Australian.

1. Tax benefits – depreciation

As well as the negative gearing benefits, property investors also benefit from depreciation – the decline in value of the actual property, fixtures and fittings over several years. Depending on the age of the property and whether it’s been renovated, this can run into thousands of dollars every years – and can be the difference between a property being negatively geared and paying for itself. Investors dismiss depreciation at their peril.

1. Tax benefits – CGT

That’s not all, either. Property also benefits from a favourable environment in relation to capital gains tax: if you sell your own home, you don’t pay any tax on the profit; meanwhile, if you sell an investment property that you’ve held for more than 12 months, you only pay capital gains tax on half of the profit. These three tax benefits mean that Australia has a uniquely favourable taxation environment for investing in property – and that’s before you start looking at investing in property via super (more on that later) or targeted schemes like NRAS.

1. You can use your super

Self-managed super funds have been around for some time – however, it’s only in recent years that investing in property via super has emerged as a feasible option due to changes in the law regarding borrowing. It’s incredibly tax-effective: CGT on sale is just 10%, and zero if you’re over 60; a recent ATO ruling also means you’re now allowed to renovate properties held within the fund too. However, you do have to stay within the rules, which are quite complex, so seek advice before going down this route.

1. It’s easier to hold onto if things go wrong

Margin calls are a common feature of shareholdings: essentially, if you’ve borrowed to invest in share, the margin call is when you are asked to deposit more money if the assets in your portfolio fall below a certain amount. However, it’s almost unheard of for a lender to ask you to top up a mortgage if a property falls in value – as long as you can keep up the repayments, you’ll be able to continue holding your property until its value increases again.

1. It’s an asset you can use

Investment or not, your property is still just that – a property. So, should events take a turn which means you have to move into that property, you can (pending rental agreements, of course) whether for the short term or the long term – and, if things change again, you can move back out, leaving your investment intact. That’s a hard thing to do with a share certificate or a bar of gold.

1. Not just investors in the market

An important factor in the robustness of the property market is that fact that it’s not just investors buying and selling property – in fact, investors are the minority. Investors account for around 30% of all mortgages taken out (ABS, July 2011), with the remaining 70% by homeowners – who aren’t necessarily buying with the principal aim of making money from property, but due to any number of reason. This provides the housing market with a base ‘floor’ of activity which, while not protecting it from ups and downs, does limit their impact somewhat.

“As long as people choose to live in houses, units & apartments, residential property will always be stable,” comments developer Troy Harris. “From the young couple who have saved enough for a deposit, to the investor renting student accommodation through to the downsizer and retirement village, residential property is always sought after.”

1. Demand is outstripping supply

Linked to this is that there is an ongoing demand for property – both rental property and property to buy. Australia’s population is growing – perhaps not as quickly as in it was between 2006 and 2009, but still at a solid pace – and housing supply remains tight in many areas (particularly capital cities and areas affected by the resources boom). This provides another floor under the market which makes it less likely that prices will crash. Do your research carefully, though, as some areas of the market do experience oversupply!

1. Limited immunity from fluctuation

Another experienced investor and market commentator, Margaret Lomas, argues that the right kind of property can also offer limited immunity against recession.

“During an economic slowdown, more demand from both buyers and tenants falls into lower markets,” she says. “[This increases] values and yields.”

1. Other people pay for your investment

In fact, it’s worth noting that, as well as being able to borrow the vast majority of the asset value and the tax benefits, you’re also getting other people – namely tenants – to subsidise your investment through rental payments. You’re getting three different parties helping you make money through capital gain (or cash flow) – making property one of the most affordable investments around.

1. The only thing Australians aren’t taxed on

One especially for the homeowner, this:professional renovator Cherie Barber points out that the family home is one of the few untaxed assets in the average Australian’s armoury.

“We get taxed on everything in Australia, but your own principal place of residence is one of the rare things left that the Australian government doesn’t tax you on,” she says. “Therefore, you can add real value to your own home through a renovation or by redeveloping your property in another way – and every dollar of value you create is yours to keep. The taxman gets none of it.”

1. Still keep growing – even when you’re retired

Many investors following a capital growth strategy are putting together a nest egg for their retirement – whether that’s based on selling down and creating a lump sum, partially selling down and living off rental income, or on living off a line of credit. However, what some investors forget is that, even after they retire in, say, 20 years, yield and value will continue to improve – making you worth more each year. Investors Direct chairman Bill Zheng also highlights that property investors are more likely to hold onto properties when they retire, due to the effort required to accumulate them.

1. It’s a more stable investment

The property market is usually much less volatile than the share market, at least partly due to the effort required in order to purchase a property – in terms of due diligence, legal checks, inspections, length of settlement periods and so on. This means that property is less prone to short-term speculators than paper asset classes. This – along with the relatively long amount of time it takes to liquidate a property asset – also reduces market volatility significantly.

“Properties in well located area's, underpinned by good supply and demand, rarely crash overnight or even over extended periods of time,” says Cherie Barber. “They hold their own or at least level off and rarely experience major falls. Investors can avoid high risk areas simply by researching suburbs and properties well before they buy.”

1. Bricks and mortar

Another factor which is comforting to many investors is that they’ve invested in something tangible – something they can ‘look at and touch’.

“[Property is one of the few investments which you can actually see and feel, and this often makes it feel more real,” says Troy Harris. “You can’t take your friends for a drive on a sunny day past your share portfolio.”

While much of this may be a psychological comfort, there’s also a monetary benefit. After all, even if the worst happens, the fabric of the property and the land underneath will still have some tangible value – unlike shares in a company that’s gone under.

1. The government’s got your back

The government of the day – regardless of party - wants house prices to remain robust. Why? Because properties house voters.

“Governments naturally look after voters who own or rent houses, they therefore can’t afford to upset them too much and are therefore unlikely to bring in legislation that adversely increases the cost of owning residential property,” says Helen Collier-Kogtevs of Real Wealth Australia. “Governments generally don’t have similar concerns for shareholders or owners of commercial or industrial property.”

Case in point: the last time negative gearing was tampered with was in 1987, when the government tried getting rid of it. The results were disastrous: investors stopped investing and rents in Sydney skyrocketed because investors didn’t buy residential property. The decision was quickly reversed negative gearing was reintroduced.